For the past few years, solar industry stakeholders have imagined a future where the general public has the ability to invest in pure-play renewable energy real estate investment trusts (REITs) that finance and construct both utility-scale and distributed photovoltaic (PV) projects in the United States. While these stakeholders wait for this reality to come to fruition, existing REITs already have several options to own or develop solar projects that still allow them to comply with the IRS's asset and income tests.
This past May, Chadbourne & Park's Kelly Kogan and Scott Bank moderated a roundtable with representatives from several REITs who discussed the options available to REITs to invest in PV systems. I've summarized these options here and provided some additional background information on how these strategies comply with existing IRS regulations.
Option 1 — Utilize a taxable REIT subsidiary (TRS) to own PV projects
A TRS is a subsidiary of an existing REIT that provides services (anything in addition to customary real estate services) to the REIT's tenants without jeopardizing its status as a REIT. Unlike its parent REIT, a TRS pays corporate income tax because the income derived from these services is not considered "good" income by the IRS. Generally speaking, good income is income derived in some way from real property. According to Will Teichman from Kimco Realty, a REIT can utilize its TRS to develop, secure financing for, and own rooftop PV systems. The TRS can pass the benefits from the ITC or 1603 cash grant to the project's investors. The TRS can also sell the power generated to the building's tenants, and it can manage all aspects of the project, including systems operations, customer billing, and securing contracts for the sale of solar renewable energy certificates. The TRS must pay taxes on this income, but it can potentially distribute some of its after-tax income to the REIT in the form of a dividend.
Option 2 — Utilize a TRS to develop and construct PV projects
A REIT can utilize a TRS to develop and construct PV projects, but instead of owning the project after construction, the TRS can sell its ownership interest to an investor or utility. Electricity generated by the project is retained by the utility or is sold to an offtaker under the conditions of a long-term power purchase agreement (PPA). In this case, the TRS only acts as a construction contractor, and the parent REIT collects rent for leasing the rooftop space to the project owner, which is considered good income by the IRS.
Option 3 — Lease space to solar developers and project owners
In this case, a REIT owns rooftop space or land but does not form a TRS to construct or develop the PV project. Instead, the REIT will lease the rooftop or land to a PV project developer, which will pay the REIT monthly rent. This rental income is considered good income by the IRS.
Option 4 — Implement a diversified approach to sustainability/energy efficiency/renewable energy financing
In this case, a mortgage REIT utilizes a diversified approach to "green" investing but focuses most of its efforts on lending for energy efficiency (EE) investments and other building structural improvements, such as efficient HVAC systems. These improvements are permanently affixed to buildings and integrated into its systems so they are classified as good assets, and any interest income on loans secured by these systems is considered good income by the IRS. When such a REIT builds up a large enough portfolio of these EE assets, it can choose to diversify its lending practices into other sectors that may not qualify as good assets or good income — such as utility-scale renewable energy projects — as long as the characteristics of these loans do not exceed the IRS's asset and income tests, which are discussed on REIT.com.
Option 5 (potential) — Form a Canadian income trust
Instead of pursuing a private-letter ruling to classify renewable energy as "real property," or conforming to existing U.S. limitations, a company could choose to form a Canadian income trust. This entity is a pass-through entity, similar to a REIT, and it trades on the Canadian stock exchange. Unlike IRS regulations, Canadian tax laws do not prohibit the types of assets this company can own, but the trust's property cannot be used to conduct business in Canada. This stipulation makes such a trust a potential option for owning PV projects in the United States. At the time of this writing, this option was actively being pursued, but to my knowledge there is not yet a Canadian income trust specializing in renewable energy projects on the Canadian stock exchange.
Table 1 below presents some selected market characteristics of the companies discussed earlier. As you can see, the types of REITs actively investing in PV projects vary widely, suggesting that investing in PV is more dependent on a REIT's corporate mission rather than its organizational structure. For example, Prologis is a large-cap REIT with $45 billion of assets under management, while PW is a small-cap REIT with only $10 million of assets under management, yet both have made significant investments in PV projects.
Despite the many obstacles standing in the way of pure-play solar REITs, the REIT pioneers discussed here have found ways to work within the existing IRS rules to develop a significant amount of PV projects. Each company offers a unique way to mine good income from the sun, and the efforts of each REIT have worked to bring more clarification as to what the future of solar REITs could look like.
This article was originally published on NREL Renewable Energy Finance and was republished with permission.
Lead image: Rooftop solar via Shutterstock